PensionsFeb 20 2020

Will Collective Defined Contribution Schemes take off?

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Will Collective Defined Contribution Schemes take off?

Collective defined contribution (CDC) schemes are now on the horizon, with Royal Mail lining up to be the first UK employer to launch this type of scheme, later this year. 

 

Already well-established in countries such as the Netherlands and Denmark, the schemes were given the green light by the then Work and Pensions Secretary, Amber Rudd, in March 2019.

The new schemes aim to bridge the gap between DB and DC schemes.

They may be attractive to companies who are keen to offer a good pension but are less keen on the liability aspects of a DB pension scheme. 

CDC schemes provide a regular retirement income by pooling and investing group contributions.

 Also known as a type of ‘defined ambition’ scheme, they pay out a target or ‘ambition’ amount, aimed at providing people with a sufficient level of index-linked pension for life.

Unlike DB schemes, members are therefore not promised a specific retirement income.

A force for good 

So, are CDC schemes a positive introduction to the range of pension-saving options available?

Sandeep Maudgil, a partner at solicitors, Slaughter and May was one of the experts called to give evidence to the House of Commons Parliamentary Select Committee on Work and Pensions when it considered CDC pensions in 2019.

He says: “Given the demographic issues which this country faces, anything which broadens the space of properly regulated ways in which people are able to provide for their retirement, particularly in a way which enables them to share the investment and longevity risks associated with retirement-benefit provision, has to be a good thing.

Fiona Tait, technical director at Intelligent Pensions agrees there is room for new options in the pensions space, as she says: “It’s always a good thing to look for new solutions, as there have been an awful lot of pressures on DB schemes.

“It is too early to say whether CDC schemes will work, but they have some very strong advocates.

"If they do get off the ground, the have the potential to be useful.”

Possible problems

Some potential issues with CDC schemes are anticipated, however, as Mr. Maudgil says: “The key issue for CDC will be communications. 

"CDC has the ‘look and feel’ of a traditional pension scheme – and that is one of its key attractions from a member and union perspective. 

"The way the benefits build up is easy to understand, and the fact that they are communicated in pension form, rather than as a retirement account capital sum which then needs to be converted into pension form before someone can understand how much income they will actually have to live off when they retire, is a major advantage over traditional DC.  

“But that can also be a drawback if members don’t understand the key difference between CDC and a traditional DB scheme, namely that CDC benefits are not guaranteed.

“This is why the government has always been clear that transparent member communications will be extremely important. 

"The Pension Schemes Bill currently going through Parliament addresses this concern by providing that the Pensions Regulator should not authorise a CDC scheme to operate unless it is satisfied that the scheme has adequate systems and processes for communicating with members.

"I expect that The Pensions Regulator will require schemes to make the non-guaranteed nature of CDC benefits explicit to members when they first join, and to remind them of that each year as part of the annual exercise of communicating to members what level of increase (or cut) is to be applied for their accrued benefits for that year.”

Kate Smith, pensions expert at Aegon agrees that communication could be an issue, and that there may be other potential downsides with regard to CDC schemes: “The industry is divided on whether CDC schemes will offer lower charges and greater certainty to savers or if they are just too complex to communicate to members, many of whom will be enrolled automatically.”

Fairness is a consideration issue too, according to Ms. Smith: “CDC schemes pool both investment and longevity risks across members but as we’ve seen from other countries, one generation can end up subsidising another.

"To reduce the risk of ‘intergenerational unfairness’, an individual’s target benefit needs to reflect what they are paying in year on year and also their age.

"Younger members should receive a higher target benefit than older members for the same contribution because of the longer period of investment before retirement.”

Henry Tapper, chief executive of AgeWage also sees potential issues with the intergenerational aspect of CDC schemes: “Young people may feel that they are subsidising the old.

"However, CDC schemes always require a degree of smoothing and with anything collective, there are always winners and losers. People will overall get more out of a CDC scheme because of economies of scale.”

The verdict

So, will they catch on?

Laura Stewart-Smith, workplace savings manager at Aviva does not expect them to become the most favoured option, as she explains: “We anticipate that the current DC regime will remain the workplace pension of choice for the vast majority of employers.”

Summing up, Maike Currie, director for workplace investing at Fidelity International says: “The jury is still out on how much of a success CDC schemes will be. It’s very early days, and the product has yet to be fully ratified through the Pension Schemes Bill.”

She adds: “CDC schemes will be definitely worth keeping an eye on as the year progresses."